Written by the American Academy of Estate Planning Attorneys
Compliments of Morris Hall
We all know that low interest rates can create excellent opportunities to buy or refinance real estate. But did you know that a low interest rate environment can have an impact on your estate planning options as well?
The four corners of a solid, basic estate plan remain the same no matter the economic climate. Interest rates do not determine the effectiveness of a Living Trust, Pourover Will, General Durable Power of Attorney, or a Healthcare Power of Attorney.
Interest rates can, however, influence the effectiveness of a number of advanced estate planning methods. Let’s take a look at just a few:
- Grantor Retained Annuity Trust. A Grantor Retained Annuity Trust, or “GRAT,” is an estate planning tool with which you establish a Trust and retain a stream of income payments (the annuity) for yourself. When the term designated for the annuity expires, the children or other family members you’ve designated as beneficiaries receive whatever assets are left in the Trust.
The purpose of establishing a GRAT is to remove highly appreciated assets from your estate by passing them on to your chosen beneficiaries during your lifetime with the lowest possible gift tax bill. When you set up a GRAT, the IRS determines the value of the gift to your remainder beneficiaries by taking the value of the assets contributed to the Trust and subtracting from this the actuarial value of the scheduled annuity payments for the term of the Trust, using the “Section 7529” interest rate. The Section 7520 interest rate is a theoretical interest rate assigned to the Trust – it is equal to 120% of the applicable federal midterm interest rate for the month the Trust is established.
When the Trust investments outperform the Section 7520 rate, the excess passes to your beneficiaries gift tax-free. This is easier to accomplish when the Section 7520 rate is low, making a GRAT a more effective estate planning strategy in a low interest rate environment.
- Charitable Lead Annuity Trust. A Charitable Lead Annuity Trust, or “CLAT,” is similar to a GRAT except that, instead of receiving the initial stream of annuity payments yourself, you designate a charity to receive them. When the Trust ends, the remainder goes to your children or other designated beneficiaries. As with a GRAT, the IRS values a CLAT using the Section 7520 rate. If the CLAT’s investments out-earn that rate, the excess passes to your beneficiaries gift and estate tax-free. This is another instance in which very low interest rates can mean the opportunity to pass on large amounts to your loved ones while minimizing your tax bill.
- Self–Cancelling Installment Note. A Self-Cancelling Installment Note, or “SCIN”, is another estate planning option for parents who want to move an asset out of their taxable estate while minimizing their gift tax liability. This strategy works well for parents whose actual life expectancy is less than the life expectancy that appears on actuarial tables.
When you use a SCIN, you sell an asset to your child in return for a stream of payments. At your death, the payments end – your child’s debt is cancelled with no further obligation. Since the asset has been transferred to your child, its value is not included in your taxable estate; instead, only the loan payments made to you count toward your estate tax bill. If the promissory note governing the transaction is properly structured, the IRS does not view the asset transfer as a gift; therefore, you also avoid gift tax liability. When interest rates are low, a SCIN can be an effective estate planning strategy because it keeps your child’s payments to you low, allowing you to transfer more wealth to your child.
- Qualified Personal Residence Trust. The Qualified Personal Residence Trust, or “QPRT,” is an example of an estate planning strategy that does not work as well in a low interest rate environment. Under this arrangement, you transfer your home into a Trust, retaining the right to live in your home for a specified number of years. After this term of years has expired, your home is transferred to your children or other beneficiaries selected by you. The goal of a QPRT is to remove your home from your taxable estate and transfer it to your children (or other beneficiaries) with the smallest possible gift tax bill. Your gift tax bill is determined by the value of your beneficiaries’ remainder interest in the home, and this is discounted more heavily with a higher interest rate.